ICIS insight: The petchem crystal ball

06 March 2006 00:00[Source: ICB]

Supply and demand balances are depressingly wrong on so many occasions and yet there remain the orthodoxy that we all so religiously depend upon to give us a guide to the future. Everybody knows that other factors drive markets much more than the intellectually adequate reliance on supply and demand.

These factors include the ability of end-users to afford raw materials, and the impact of unforeseen market catastrophes such as 2003’s Sars outbreak. Plus in China you have to add the seemingly unsolvable riddle of inventory levels. But most of the chemical industry seems to have given up on creating a methodology to measure these other factors because it seems just too difficult. The industry relies on supply and demand only because there is nothing else.

Consultants, and probably companies without going public, have on occasion attempted to break the mould. But these efforts have yet to gain universal acceptance, maybe because of a lack of trust in the reliability of sentiment indexes and inventory assessments. This seems a little ironic given the constant wide divergence of opinions on how many plants are starting up and what consumption growth will be.

Take, as an example, last month’s 1st Asian Olefins Conference, organised in Shanghai by ICIS and sponsored by Integra. Yves Bonte, senior vice president, sales and marketing for Basell International, gave a pessimistic, or maybe a realistic, view of the global polyolefins markets. According to him, Asian polypropylene (PP) capacity could grow at 6.3%/year from 2004-2010, if you included speculative projects. Basell gives percentage ratings on the likelihood of projects going ahead, which it then uses in scenario planning.

With smaller integrated Chinese producers likely to continue to run, he expects there to be more balanced demand and supply in Asia, pushing out traditional PP imports. Polyethylene (PE) was already showing global overcapacity in 2005-2006 and this is expected to worsen by 2009-2010. Bonte also predicted global oversupply of 2.5m tonne by 2010 as he challenged the assumption that China would be the never-ending sink for global polyolefins. His forecast for PE demand growth in China between 2004-10 was only 6%. This is lower than gross domestic product (GDP) growth, which is likely to remain in excess of 8% during the period.

John King, vice president and director of Nexant (Thailand), gave a more upbeat assessment. He forecast that supply deficits in China across a range of products including PE (see chart) would need significant new investments over the next 10-12 years. The question was where these capacities would be built; the Middle East is the clear favourite for PE, he added.

Devising trusted alternatives to supply and demand measurements requires significant resources. If only half as much shoe leather was devoted to assessing sentiment and inventory levels as is devoted to counting new plant start-ups, then maybe we would have an accepted alternative set of measurements. It is difficult, but surely not impossible, to come up with a system that works reasonably well and that could be used along with supply and demand assessments.

Take Sars. Nobody anticipated the fall-out would be as severe as to reduce China’s GDP growth by a couple of percentage points. But if a calculation had been made of how often the disease was being mentioned in the media and by traders, distributors and buyers down the production chains, this would have gone part of the way towards predicting the full Sars impact.

These references to Sars would then have had to be weighted to work out just how seriously the disease was being taken. Both these assessments – of frequency and severity – would have had to be constantly adjusted as the disease gained momentum. Mathematically, this is a big challenge, but surely not beyond the wit of man.

Inventory levels in China are a powerful trade secret. Traders and distributors (who often act as traders) don’t want to show their hands because their success depends on deceiving producers, consultants and price reporters. Assume everyone will lie about their inventories. No trader worth his salt would want to admit that he had 70 days of inventory and was desperate to sell.

Measuring the distance between real and apparent demand in China is a nightmare. If a producer ramps up operating rates on the assumption that real demand is good, he will contribute to a price collapse.

However, a collective assessment of what a representative cross-section is saying about inventories would be of some value. If the majority are saying that inventories are high, the majority view will shape the direction of markets, because at least nine-tenths of reality is perception. The over-reaction to Sars, which never became a genuine epidemic despite the frequent use of the term in the media, is a prime example of this.

Challenging conventional wisdom is at the very least always good fun. It’s much more enjoyable to be iconoclastic; to be more than just another grey suit shuffling between conferences, hearing one presentation after another that detail wrong supply and demand projections. And challenging the faith might just produce the solutions that the chemical industry so badly needs.